Firm Valuation Calculator (Discounted Cash Flow)
Use this calculator to estimate a firm's Enterprise Value using the Discounted Cash Flow (DCF) method. This method projects a company's future free cash flows and discounts them back to their present value to arrive at a valuation.
The company's free cash flow for the most recent period (e.g., current year). Enter as a positive number.
The expected annual growth rate of FCF during the explicit projection period (e.g., 5-10 years). Enter as a percentage (e.g., 5 for 5%).
The number of years for which you explicitly project free cash flows (typically 5-10 years).
The constant growth rate at which FCF is expected to grow indefinitely after the projection period. This is usually a low, stable rate (e.g., 1-3%). Enter as a percentage.
The company's Weighted Average Cost of Capital, used to discount future cash flows. Enter as a percentage (e.g., 10 for 10%).
Understanding Firm Valuation with the DCF Method
Firm valuation is the process of determining the economic value of an entire business or company. It's a critical exercise for investors, business owners, and financial analysts to make informed decisions about investments, mergers, acquisitions, or divestitures. While there are several methods for valuing a firm, the Discounted Cash Flow (DCF) method is one of the most robust and widely used.
What is the Discounted Cash Flow (DCF) Method?
The DCF method is based on the principle that the value of a business is the sum of its future free cash flows, discounted back to their present value. In essence, it answers the question: "How much is a stream of future cash flows worth today?"
The core idea is that a dollar received in the future is worth less than a dollar received today due to factors like inflation, opportunity cost, and risk. The DCF model systematically accounts for this by using a discount rate to bring all future cash flows to a common present value.
Key Components of the DCF Valuation
Our calculator uses the following key inputs, which are fundamental to the DCF model:
- Current Free Cash Flow (FCF): This is the cash a company generates after accounting for cash outflows to support its operations and maintain its capital assets. It represents the cash available to all capital providers (debt and equity holders). A positive FCF indicates a company has cash left over after expenses and capital expenditures.
- FCF Growth Rate (Projection Period): This is the estimated annual rate at which the company's free cash flow is expected to grow during a specific, explicit forecast period (e.g., the next 5-10 years). This rate is often based on historical performance, industry trends, and management's projections.
- Number of Projection Years: This defines the length of the explicit forecast period. Typically, analysts project FCF for 5 to 10 years, as forecasting beyond this period becomes increasingly uncertain.
- Terminal Growth Rate: After the explicit projection period, it's assumed that the company will continue to generate cash flows indefinitely, but at a more stable, lower growth rate. This "terminal growth rate" is usually a perpetual growth rate, often tied to the long-term growth rate of the economy or inflation (e.g., 1-3%).
- Weighted Average Cost of Capital (WACC): This is the discount rate used to bring future cash flows back to their present value. WACC represents the average rate of return a company expects to pay to all its security holders (debt and equity) to finance its assets. It reflects the overall risk of the company and its cash flows. A higher WACC implies higher risk and results in a lower present value.
How the Calculator Works (The DCF Formula)
The calculator performs the following steps:
- Projects Free Cash Flows: It takes your Current FCF and applies the FCF Growth Rate for each of the Projection Years to estimate future FCFs.
- Discounts Projected FCFs: Each projected FCF is then discounted back to its present value using the WACC.
- Calculates Terminal Value: At the end of the projection period, the calculator estimates the "Terminal Value." This represents the value of all cash flows beyond the explicit forecast period, growing at the Terminal Growth Rate indefinitely. The Gordon Growth Model is commonly used for this:
Terminal Value = FCF(Year after projection) / (WACC - Terminal Growth Rate). - Discounts Terminal Value: The calculated Terminal Value is then discounted back to the present value, similar to the individual FCFs.
- Sums Present Values: Finally, all the present values of the explicit FCFs and the present value of the Terminal Value are summed up to arrive at the total Enterprise Value of the firm.
Example Calculation
Let's use the default values in the calculator to illustrate:
- Current Free Cash Flow (FCF): $10,000,000
- FCF Growth Rate (Projection Period): 5%
- Number of Projection Years: 5
- Terminal Growth Rate: 2%
- Weighted Average Cost of Capital (WACC): 10%
Based on these inputs, the calculator would perform the following (simplified):
- Project FCFs:
- Year 1 FCF: $10,000,000 * (1 + 0.05) = $10,500,000
- Year 2 FCF: $10,500,000 * (1 + 0.05) = $11,025,000
- …and so on for 5 years.
- Discount FCFs: Each of these projected FCFs is discounted back using the 10% WACC.
- Calculate Terminal Value:
- FCF in Year 6 (Year after projection): $12,762,815.63 (FCF of Year 5) * (1 + 0.02) = $13,018,072.00
- Terminal Value = $13,018,072.00 / (0.10 – 0.02) = $162,725,900.00
- Discount Terminal Value: The $162,725,900.00 Terminal Value is discounted back 5 years at 10% WACC.
- Sum Present Values: The sum of all discounted FCFs and the discounted Terminal Value yields an Enterprise Value of approximately $144,622,601.54.
Important Considerations
- Assumptions Matter: The DCF model is highly sensitive to its inputs. Small changes in growth rates or WACC can significantly alter the valuation. Therefore, it's crucial to use realistic and well-justified assumptions.
- WACC vs. Terminal Growth Rate: The WACC must always be greater than the Terminal Growth Rate. If the Terminal Growth Rate is equal to or higher than the WACC, the formula for Terminal Value results in an infinite or negative value, which is not economically sound.
- Enterprise Value vs. Equity Value: This calculator provides the Enterprise Value, which is the total value of the company, including both debt and equity. To get the Equity Value (the value attributable to shareholders), you would typically subtract Net Debt (Total Debt – Cash & Equivalents) from the Enterprise Value.
While powerful, the DCF method is just one tool in a valuer's toolkit. It's often used in conjunction with other valuation methods, such as comparable company analysis (multiples) and precedent transactions, to arrive at a comprehensive valuation range.